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Interview with Handelsblatt

Interview with Danièle Nouy, Chair of the Supervisory Board of the ECB, conducted by Yasmin Osman and Michael Maisch and published on 18 April 2017

Ms Nouy, the great financial crisis erupted ten years ago. How likely do you think it is that banks will trigger such a crisis again?

One should never say never, but since then banks have become more resilient. Of course, there will also be crises in the future. But I hope we will be better prepared then. The consequences would certainly be less dramatic, not least because we have more useful tools to defend ourselves with than at that time.

Are you satisfied with the resilience then, particularly of the European banking system?

To be honest, I don’t know whether we have such a thing as a European banking system at all. The structures in the respective EU countries are still very diverse. And, of course, some banks still have to do their “homework”. Non-performing loans (NPLs) remain a key priority. They weaken the banking system. When a bank has too many NPLs, being profitable is difficult. The economy also suffers because it’s hard for banks with high NPLs to make additional loans available.

The ECB is urging banks to get rid of their bad debts. Will some banks have to be wound up if they don’t keep pace with the timetables of the ECB’s supervisors?

We have asked banks to give us very detailed plans as to how they are dealing with their NPLs. The supervisors ensure that the plans are ambitious but still realistic. We shall not be dispensing medicine in such a way that the patient dies. And there can be no “one-size-fits-all” solution for all banks. But what matters to us for the future is that banks do not lay the foundations for new bad debts.

How will that work?

Of course, nobody knows in advance which loans will become non-performing ones. So our focus is to check carefully that lending practices and risk management are safe and sound. That was not always the case before the crisis. We also make sure that banks have sufficient staff and the necessary tools to recognise at an early stage when there are problems with a loan. The slower banks react, the more difficult it is to get a loan back on track.

The head of the European Banking Authority (EBA), Andrea Enria, has proposed a Europe-wide bad bank for bad debts. His idea is facing resistance from national heads of government. What do you think of the proposal?

Given the size of the problem — and we are talking about bad debts in the order of €921 billion — we need all the instruments we can have. That’s why I am grateful to Andrea Enria for his proposal, even if I don’t agree with him on everything. For example, one problem with his proposal is that the price the bad debts ultimately fetch will stay unclear for a long time. But knowing this would be important for a bank wishing to transfer a portfolio.

Which aspects do you think are good?

Such a fund is not a panacea. But when so many banks want to sell their NPLs, they are not in a strong negotiating position. It’s a buyer’s market. It would be different with a common European asset manager. A European initiative of this kind would also be possible without EU money.

Then where would the money come from?

It could be something financed nationally, or with the help of private money. A European initiative would have the advantage of not carrying a stigma. There are many different causes for non-performing loans, such as a lack of growth or an economic crisis. But there are also problem loans in countries where bad debts are simply not reduced with sufficient determination. Even in countries in which really there have not been very many bad loans.

You’re not hinting at bad shipping loans in Germany, are you?

Well, as with all legacy assets, addressing them is done bank by bank, with ambitious but realistic plans to reduce them. Shipping loans in Germany provide a good example of how we approach shared problems and how to address NPLs. We have worked with colleagues in Germany on shipping loans. This has been a good example of how European-level supervision works well – and how we are better working together. We come at the problem in different ways and complement the work we would have done had we addressed it on our own. The example shows that even a country in which there are, all in all, few bad debts could be interested in this subject.

The hotspot for bad debts is Italy, however. After Monte dei Paschi, two other regional banks have requested so-called “precautionary recapitalisation”. Shouldn’t such banks simply be wound up?

The process of securing a precautionary recapitalisation is a complex one. Banks have to ask for it – which means their owners have to accept that their ownership rights will be totally diluted. The national government has to be willing and able to support the bank with state money – with a view to safeguarding financial stability. Then this has to be conveyed to the European Commission, which makes the decision. The role of the ECB is to assess whether the bank is solvent and, assuming it is, then to identify the capital shortfall based on strict criteria. Declaring a bank no longer solvent is a very serious step. It’s a process that follows precise rules and the scope for discretion is not very large.

Perhaps you don’t have the necessary determination to go that far?

We are not the only institution able to initiate the resolution of a bank. Elke König, Chair of the Single Resolution Board, can also do so. So far, therefore, two European institutions have assessed Monte dei Paschi to be solvent. Ms König recently told members of the European Parliament, in effect, that we have some banks which are in “shaky waters”, but are still solvent. I couldn’t have put it any better.

Where are the most dangerous shallows for Europe’s banks at the moment?

Apart from the legacy issues, which are the most pressing, problems with earnings are a serious matter. For banks to become better capitalised and stronger banks, they need to raise equity – which a number of banks have been doing – or retain their earnings. If they are unprofitable, it’s difficult for banks to raise fresh capital or retain earnings. The low earnings are due to many factors. Non-performing loans are a factor. But of course the interest rate environment is also beginning to take its toll, with the benefits having already been received by banks – the reduction in the costs of funding, the increase in value of certain bank assets, and better quality of credit for borrowers. The high development costs and the challenges of digitalisation are also a constraint. The cost-to-income ratio for banks in the euro area is also pretty high – the average is at about 65%, meaning that in some countries, it’s even higher than that. This is particularly the case here in Germany where the cost-to-income ratio is one of the highest in the euro area. It may be due to overcapacity. So banks have to review their business models and adapt to changing times.

Interest rates have never been so low for so long. How many banks will be unable to cope with a future rise in rates and fail?

Let’s hope no bank experiences that. As bank supervisor, we indeed try to step in early, preferably before anything happens. And that’s why we have just started to analyse how vulnerable banks are to interest rate risk in their banking books. I should add that we have no insight into the central banking activities of the ECB but it is just common sense for supervisors to make this kind of risk sensitivity analysis. And also it is something which the Basel Committee requires supervisors to undertake.

...and in the process, there are checks made to see what happens if interest rates suddenly go up or down by two percentage points. Will many banks fail?

It is not a matter of passing or failing. This year there’s no EBA stress test. We have therefore decided to analyse the interest rate risks ourselves. Not mechanistically, but closely focused on individual banks. We want to add a comparative dimension to the work we have done at a bank-by-bank level to provide us with some benchmarks for similar types of banks. The results will also influence the Pillar 2 guidance on capital, which we will be defining for the banks.

That will therefore only be part of the voluntary guidance on capital and not part of the individual mandatory capital buffers that you are prescribing?

In this regard, the European Commission’s criteria are applicable, which oblige us to divide the capital surcharges between a mandatory requirement and guidance. A stress test is a hypothetical scenario and so, according to the clarifications on capital requirement and capital guidance, which we had sought and received from the legislators, that is indeed covered by the guidance. Moreover, we see the outcome of this sensitivity analysis calling for more qualitative measures, and these are difficult to translate into a specific capital ratio.

We have already spoken of costs being too high and profits too low. Could a consolidation of the European banking market be part of the solution?

Definitely. Consolidation is absolutely necessary, and the sooner it comes the better.

Does that also apply to cross-border mergers?

That is what the market participants expect. With the banking union we have created a pan-European market. To that extent, pan-European banks would be a logical step. But, of course, there can also be mergers or acquisitions that make sense at national level. However, the decision about which mergers make sense should not be made by the supervisor, but first and foremost by the market and the investors. We, as supervisors, would then check every proposal very thoroughly and determine what conditions to attach to specific mergers so that the new entities are strong from the start.

But wouldn’t the market first need a signal from the supervisor that it doesn’t harbour any reservations about even larger banks?

Of course we should not create any new banks that are so big that, in the event of an acute crisis, they would have to be rescued by the state. However, the sheer size is not what concerns me most. Complexity is the greater risk, in my opinion. The mergers must make sense, and the new bank must be stable and secure from day one. What we don’t want is mergers between weak institutions; that would not make the new entity stronger. Two ugly ducklings don’t make a swan. In that regard, we will be very vigilant.

How vigilant are you at the moment then with regard to deregulation of the financial sector?

Of course we have to be careful. There are some people who believe that higher capital requirements prevent banks from granting more loans. I, on the other hand, am convinced that only well-capitalised banks are capable of supporting the economy sustainably with loans throughout the economic cycle. That’s why the reforms which have been initiated and which will take until 2019 to be implemented were sensible. Any watering-down would, in my opinion, be a mistake.

The new US President has already announced a clear deregulation of the financial sector. As soon as he has nominated close allies to the most important US authorities, they could also put pressure on international regulatory bodies, such as the Basel Committee on Banking Supervision, couldn’t they?

I don’t have a crystal ball, of course. But I would be sceptical insofar as your fears are concerned.

But the Americans and Europeans have in any case fallen out at the Basel negotiations over the completion of the new banking regulations. Is it still possible to rescue the reform project?

I am optimistic that we will come to an agreement. We have already done a lot of the work and are very close to a compromise. I am very confident that this progress will not be lost. I am more concerned about possible changes to the European capital requirements rules – the Capital Requirements Directive (CRD IV) and the Capital Requirements Regulation (CRR). Some of the current proposals would limit the discretion of the supervisor, for example with regard to the details of the Pillar 2 capital requirements for banks. I don’t imagine we can and should decide how many basis points of additional capital should be allocated for each risk category. If there is one thing we learned from the financial crisis, it is that risks are interrelated and affect each other.

Your term of office as the first head of banking supervision at the ECB runs until the end of next year. Can you already draw any conclusions?

The main lesson for me is that it really was an excellent idea to create a banking union with uniform supervision of all the large banks in the euro area. We work better together: ECB staff and national supervisors. The setting-up of the Single Resolution Board in Brussels was also a very sensible step. Unfortunately, one of the pillars of the banking union, a common deposit insurance scheme, is still missing. This step needs to follow.

But Germany in particular fears that that would bring about a communitisation of risks. The programme is anything but popular.

I know, but the measures are necessary. The risk reduction programme associated with the common deposit insurance scheme should start as soon as possible. In the end, everyone would benefit from the completion of the banking union – banks, citizens and the whole economy.

Was it then such a good idea to locate European banking supervision under the umbrella of the ECB? Isn’t there a risk of too many conflicts of interest between monetary policy and ensuring the stability of the banking sector?

I know that is a widely held view in Germany, but even in my previous role in France I was always an absolutely independent banking supervisor within a central bank. At the ECB, we have very strict rules on the separation of monetary policy and supervision, and so far I have not experienced any conflicts of interest. We simply do what we have to do.

It is not just about conflicts of interest. The European Court of Auditors has complained that the ECB has not provided it with all the documents it needs to scrutinise the efficiency of banking supervision.

We would be having the same discussion even if European banking supervision were not under the umbrella of the ECB. We are looking for ways to provide the Court of Auditors with the necessary information without breaching our duty of confidentiality. We are doing what we can, for example by anonymising documents before we pass them on. But we must comply with the rules, which, by the way, we did not write ourselves. At present, a new review is taking place, and I believe that the two sides now have a better understanding of the relevant rules.

Are you taking the recommendations of the Court of Auditors into account, for example with regard to the composition of the supervisory teams? The Court of Auditors has criticised the ECB for relying too heavily on the supervisors from the national authorities and the fact that most of the supervisory teams are still led by inspectors from the home country of the supervised bank.

From our point of view, it would be very nice if inspectors from one country would go into the banks of other countries and vice versa. This is the kind of approach we adopted at the ECB from the start, with the Heads of the Joint Supervisory Teams not having the same nationality as the banks they supervise. But that is not so simple for on-site inspections. A number of banks would not accept inspections being conducted in English; also, not all national inspectors are fully able to work in English, and/or willing to be deployed outside of their country. But we are taking steps to change the job description for newly appointed inspectors, so that good English language skills are now mandatory and deployment to other euro area countries is now an option. We are therefore trying to move things forward.

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